Now's the Time
BY Rose Greene
February 08 2011 5:00 AM ET
Retirement isn’t the same for everyone, so financial specialist Rose Greene offers help on determining what individual retirement account will best suit you for your golden years.
Savvy investors often plan ahead for retirement with one of two main types of individual retirement accounts: traditional or Roth. In a traditional IRA, you contribute money pre-tax each year (to a $5,000 or $6,000 annual max depending on your age), and then when you withdraw that money in retirement, it is considered income and taxed as such.
In a Roth IRA, investors put in money they’ve already paid the taxes on, so when it’s time to make a withdrawal (at age 59½ or older, and after investing for at least five years), savers don’t have to take that tax gut-punch that traditional IRA investors get socked with. Roth is ideal for a younger investor, making less money and being taxed at a lower rate than he or she expects at the end of a career or in retirement. Just think: Would you rather pay tax on $5,000 each year before investing it and pay no taxes later, or would you rather avoid paying the tax on contributions now but pay taxes on the possible $1 million your compounding account could accrue at your retirement age?
So how do you know if a traditional IRA should be converted to a Roth? Switching means paying the taxes on whatever money is currently in your traditional IRA, so you must ask yourself whether you have that money to pay the taxes now. (The conversion can happen in portions too, to lower the tax burden when switching — consult your tax expert.) Also, do you intend to leave a beneficiary money from your IRA after your death? If so, a Roth means that beneficiary won’t pay taxes on that money.
One last note: If your traditional IRA took a hit in the economic downturn, switching means you’d be paying less tax than if it were earning big returns. Also, taxes are pretty low, and chances are they’ll go up in the future. If you invest in a Roth and pay a lower tax rate now, you’ll come out with more money than if you paid a higher marginal rate on your traditional IRA withdrawals in the future.